MSRB NOTICE 2005-36 (JUNE 21, 2005)

MSRB FILES AN AMENDMENT TO RULE G-37(C), CONCERNING SOLICITATION AND COORDINATION OF PAYMENTS TO POLITICAL PARTIES, AND QUESTION AND ANSWER GUIDANCE ON SUPERVISORY PROCEDURES RELATED TO RULE G-37(D), ON INDIRECT VIOLATIONS

On June 21, 2005 the Municipal Securities Rulemaking Board  (the “MSRB”) filed with the Securities and Exchange Commission (the “SEC”) a proposed rule change consisting of  an amendment to Rule G-37(c), concerning solicitation and coordination of payments to political parties, and Question and Answer (“Q&A”) guidance on supervisory procedures related to Rule G-37(d), on indirect violations.[1]  The proposed rule change will become effective after approval by the SEC.

The MSRB previously published a notice for comment on draft amendments to Rule G-37(c), concerning solicitation and coordination of payments to political parties, and draft Q&A guidance on supervisory procedures related to Rule G-37(d), on indirect violations (the “February 2005 Notice”).[2]  The MSRB received seven comments on the proposed rule change.  The MSRB’s filing with the SEC includes a discussion of the comments received on the February 2005 Notice.

The proposed rule change is important because it will help inhibit practices that create the appearance of attempting to influence the awarding of municipal securities business through an indirect violation of Rule G-37.  The MSRB also believes that the additional Q&A guidance will facilitate dealer compliance with Rule G-37(d)’s prohibitions on indirect rule violations. 

SUMMARY OF PROPOSED RULE G-37(c) AMENDMENT

Rule G-37(c) prohibits a dealer and its municipal finance professionals (“MFPs”) from soliciting any person or political action committee (“PAC”) to make or coordinate contributions to an official of an issuer with which the dealer is engaging or is seeking to engage in municipal securities business.   The proposed amendments would also prohibit the dealer and certain MFPs[3] from soliciting any person or PAC to make or coordinate a payment to a political party of a state or locality where the dealer is engaging or is seeking to engage in municipal securities business.[4]  The proposed rule amendments would specifically define any “person”[5] to include any affiliated entity of the dealer.  This clarification is intended to alert dealers and MFPs that influencing the disbursement decisions of affiliated entities or PACs may constitute a direct violation of Rule G-37(c), as amended, if the dealer or MFP solicits the affiliated entity or PAC to make or coordinate contributions to an official of an issuer or a political party of a state or locality where the dealer is engaging or is seeking to engage in municipal securities business.  Accordingly, in order to ensure compliance with Rule G-37(c), dealers should consider the adequacy of their information barriers with affiliated entities, or PACs controlled by affiliated entities, to ensure that the affiliated entities’ contributions, payments, or PAC disbursement decisions are neither influenced by the dealer or its MFPs, nor communicated to its MFPs. 

SUMMARY OF PROPOSED QUESTIONS AND ANSWERS (“Qs&As”)

The proposed Q&A guidance provides that, in order to ensure compliance with Rule G-27(c) as it relates to payments to political parties or PACs and Rule G-37(d), each dealer must adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that neither the dealer nor its MFPs are using payments to political parties and non-dealer controlled PACs to contribute indirectly to an official of an issuer.[6] The draft Q&A guidance also explicitly states that contributing to “housekeeping”, “conference” or “overhead” type accounts is not a safe harbor and does not alleviate the dealer’s supervisory obligation to conduct this due diligence. 

The Qs&As seek to provide dealers with more guidance as they develop procedures to ensure compliance with both the language and the spirit of Rule G-37.  The Qs&As emphasize the necessity for adequate supervisory procedures to ensure compliance with Rule G-37(d) not only with respect to payments to political parties, but also with respect to contributions to and disbursements by dealer-affiliated (but not controlled) PACs.  The Board reminds dealers that a failure to implement satisfactory written procedures to ensure compliance with Rule G-37(d) could subject the dealer to enforcement actions by the appropriate regulatory authorities. 

Questions regarding the proposed rule change may be directed to Carolyn Walsh, Senior Associate General Counsel.

June 21, 2005

* * * * *

Text of Amendment[7]

Rule G-37(c).

Rule G-37: Political Contributions and Prohibitions on Municipal Securities Business

(a) – (b) No change.

(c)        (i) No broker, dealer or municipal securities dealer or any municipal finance professional of the broker, dealer or municipal securities dealer shall solicit any person, including but not limited to any affiliated entity of the broker, dealer or municipal securities dealer, or political action committee to make any contribution, or shall coordinate any contributions, to an official of an issuer with which the broker, dealer or municipal securities dealer is engaging or is seeking to engage in municipal securities business.

            (ii) No broker, dealer or municipal securities dealer or any individual designated as a municipal finance professional of the broker, dealer or municipal securities dealer pursuant to subparagraphs (A), (B), or (C) of paragraph (g)(iv) of this rule shall solicit any person, including but not limited to any affiliated entity of the broker, dealer or municipal securities dealer, or political action committee to make any payment, or shall coordinate any payments, to a political party of a state or locality where the broker, dealer or municipal securities dealer is engaging or is seeking to engage in municipal securities business.  

(d) – (j) No change.

Rule G-37 Questions-and-Answers

Q:  Is a broker, dealer or municipal securities dealer (“dealer”) required to have written supervisory procedures reasonably designed to ensure compliance with Rule G-37(d), on indirect contributions and solicitations, with regard to payments to political parties and PACs by a dealer or its municipal finance professionals (“MFPs”)?

A:  Yes.  The relevant portion of the MSRB’s supervision rule, Rule G-27(c), provides that, “Each dealer shall adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance [with MSRB rules].”

Rule G-37(d) provides that: “No broker, dealer or municipal securities dealer or any municipal finance professional of the broker, dealer or municipal securities dealer shall, directly or indirectly, through or by any other person or means, do any act which would result in a violation of sections (b) or (c) of this rule.”  While Rule G-37 was adopted to deal specifically with contributions made to officials of issuers by dealers and municipal finance professionals, and political action committees (“PACs”) controlled by dealers or MFPs, this section of the rule also prohibits MFPs and dealers from using conduits—such as, but not limited to parties, PACs, affiliates, consultants, lawyers or spouses—to contribute indirectly to an issuer official if such MFP or dealer can not give directly to the issuer without triggering the ban on business.

In order to ensure compliance with Rule G-27(c) as it relates to payments to political parties or PACs and Rule G-37(d), each dealer must adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that neither the dealer nor its MFPs are using payments to political parties and non-dealer controlled PACs to contribute indirectly to an official of an issuer.[8] For example, a dealer’s written supervisory procedures might provide that, if the dealer or any of its MFPs want to make payments to political parties or PACs, the dealer must perform adequate due diligence prior to allowing political party or PAC payments by the dealer or its MFPs to reasonably ensure that neither the dealer nor its MFPs are using payments to political parties or non-dealer controlled PACs to contribute indirectly to an official of an issuer.[9]  Such due diligence also might include inquiring about and documenting the intent or motive in making the payment, whether the party payment or PAC contribution was solicited by anyone, and if so, the identification of the person soliciting the party payment and a record of written solicitations.  This information will assist the dealer in determining whether the facts and circumstances surrounding the payment support the reason given for making the payment. 

In addition, to ensure compliance with Rule G-37(d) in connection with contributions by dealers or MFPs to non-controlled (but affiliated) PACs[10], the dealer might adopt information barriers between any affiliated PACs and the dealer or its MFPs.  Examples of such information barrier provisions might include such things as:

• a prohibition on the dealer or MFPs from recommending, nominating, appointing or approving the management of affiliated PACs;

• a prohibition on sharing the affiliated PAC’s meeting agenda, meeting schedule, or meeting minutes;

• a prohibition on identification of prior affiliated PAC contributions, planned PAC contributions or anticipated PAC contributions;

• a prohibition on directly providing or coordinating information about prior negotiated municipal securities business, solicited municipal securities business, and planned solicitations of municipal securities business; and

• other such information barriers as the firm deems appropriate to effectively monitor conflicting interests and prevent abuses.

These examples are not exclusive and are only suggestions for supervisory procedures that dealers could consider.  Each dealer is required under Rule G-27, on supervision, to evaluate its own circumstances and develop written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance with Rule G-37, on indirect violations.

Q:  Is a dealer required to have written supervisory procedures in place to ensure compliance with Rule G-37(d) if the dealer only allows the dealer or its municipal finance professionals (“MFPs”) to make political party payments to “housekeeping”, “conference” or “overhead” type accounts of a political party?

A:  Yes.  There is no safe harbor under Rule G-37 for payments to “housekeeping”, “conference” or “overhead” type political party accounts.  The dealer must have adequate supervisory procedures reasonably designed to prevent a violation of Rule G-37(d), on indirect political contributions, even when the payments are being made to a “housekeeping”, “conference” or “overhead” type account.  While the political party itself may prohibit direct contributions to issuer official candidates from “housekeeping” accounts, payments to these accounts might be used for political party events that are focused to benefit a specific candidate or a small number of candidates.  Additionally, because money is fungible, a payment made to a fund earmarked for non-issuer official elections might “free up” other money to support the candidacy of specific issuer officials. 

The need for dealers to adopt adequate written supervisory procedures to prevent indirect violations via “housekeeping”, “conference” or “overhead” type political party accounts is especially important in light of media and other reports that issuer agents have informed dealers and MFPs that, if they are prohibited from contributing directly to an issuer official’s campaign, they should contribute to an affiliated party’s “housekeeping” account.  In addition, NASD staff has informed the MSRB that some firms make contributions to “housekeeping” accounts or PAC’s with explicit instructions accompanying the payment that the specific payment is not to be used for the benefit of one or a limited number of issuer officials.  The MSRB does not consider such “preemptive” disclosures or instructions sufficient to meet the dealer’s obligation to perform due diligence to reasonably ensure that the payment to the political party or PAC is not being made to circumvent the requirements of Rule G-37.


[1] File No. SR-MSRB-2005-12.  Comments on the proposed rule change should be submitted to the SEC and should reference this file number.

[3] The proposed amendment limits MFPs who would be prohibited from soliciting or coordinating political party payments to those persons who are directly involved in the dealer’s municipal securities business.  The proposed language provides that only MFPs who are primarily engaged in municipal representative activities, solicitors of municipal securities business, or direct supervisors of MFPs that are “solicitors” or “primarily engaged” are prohibited from soliciting political party payments.  The Board limited those MFPs covered by the proposed amendments to those directly involved in the municipal securities business of the dealer; recognizing that other MFPs more distant from the day-to-day operations of the dealer’s municipal securities business may have other reasons to solicit or coordinate payments to political parties (i.e., reasons related to other business activities of the dealer).

[4] The MSRB notes that, depending upon the facts and circumstances, an MFP’s solicitation of a contribution to an issuer with which the dealer is engaging or is seeking to engage in municipal securities business or the solicitation of a political party payment to a political party of a state or locality where the dealer is engaging or is seeking to engage in municipal securities business, may also constitute a violation of Rule G-37(d), on indirect violations. 

[5] “Person” is defined in the Securities Exchange Act of 1934 (the “Act”), § 3(9) to mean “a natural person, company, government, or political subdivision, agency, or instrumentality of a government.”  Unless the context otherwise specifically requires, the terms used in MSRB rules have the meanings set forth in the Act.  See MSRB Rule D-1.

[6] In addition, pursuant to MSRB Rule G-8(a)(xx), on records concerning compliance with Rule G-27, each dealer must maintain and keep current the records required under Rules G-27(c) and G-27 (d).

[7] Underlining indicates new language; brackets indicate deletions.

[8] In addition, pursuant to MSRB Rule G-8(a)(xx), on Records Concerning Compliance with Rule G-27, each dealer must maintain and keep current the records required under Rules G-27(c) and G-27 (d).

[9] See Rule G-37 Questions and Answers Nos. III. 4 and III.5, reprinted in MSRB Rule Book.   

[10] For the purposes of this guidance the term “affiliated PAC” means a PAC controlled by an affiliated entity of a dealer.  An “affiliated entity” is an entity that controls, is controlled by or is under common control with the dealer.